The last thing in the mind of a landlord or a rental property management company is having to evict a tenant due to rent non-payment. But let us first acknowledge that the vast majority of tenants do not intend to fail to pay their rent nor live in an apartment for free.
However, when tenants default on rent payment, the landlord takes the dip financially. And even if you give the tenant a notice of eviction, plenty of legal complications can emanate from the tenant mounting defense against the eviction. It is best to safeguard yourself from such problems, and one of the best ways to do this is by incorporating income verification in your tenant screening process.
So, what is proof of income, and why is it important? Still, what documents can you rely on to verify a potential renter’s income? Keep reading for clear answers to these questions and others.
Table of Contents
- The Importance of Proof of Income
- Proof of Income Documents
- Income Verification for Potential Renters Without a Conventional Salary
- Red Flags to Watch out For
- Determining if a Renter Meets Income Requirements
- The Bottom Line
The Importance of Proof of Income
Proof of income is a document or letter that potential tenant gives you, the landlord or rental property manager, to verify that they can comfortably afford rent.
Proof of income is vital for two reasons. One, whereas you may ask tenants how much they earn to gauge their ability to pay rent, note that this number is self-reported, and people can enter any figure in the rental application form.
Secondly, most prospective tenants overestimate the rent they can afford based on their annual income without accounting for deductions like taxes and loan payments, among other expenses. Using the financial documents supplied to you, you can run the numbers and accurately determine an individual’s ability to afford rent consistently.
Proof of Income Documents
Prospective renters are required to submit certain documents as proof of income. The list below consists of the typical documents landlords and rental property management companies require prospective tenants to produce for income verification. A good rule of thumb is to demand at least two documents to put false claims at bay.
Also known as a pay stub, a payslip is often considered the strongest proof of income. It is a document from the potential renter’s employer detailing the tenant’s salary/hourly rate and the corresponding deductions. But you will want to contact the employer to validate the document.
Salary Verification Letter
Also known as a proof of income letter, a salary verification letter often offers fewer details than a payslip. An employer writes this letter describing the individual’s role in the company, their earnings, and the period they have been working there.
A salary verification income can also serve as a letter of recommendation that assures you that the renter is a trustworthy individual. An alternative to this letter would be an email or phone call from the employer.
Social Security Statement
Offered by the Social Security Administration, a social security statement is a document that details the earning history of a potential tenant to determine how much they will obtain in benefits in the future. It ranks among the most reliable proof of income documents because it is a federal document that renters can easily access. You can get your social security statement at mySocialSecurity.
Tax Form 1040
Tax form 1040/ tax return details all the sources of income a prospective tenant has generated over the tax year. The primary issue with this document is that it only proves the income earned in the previous year. To get a more accurate report, you will need to determine if the renter’s job status or circumstances have changed since then. Also, ensure the date of the tax return is the most current.
A W-2 statement details exactly how much a potential renter earned over the past year. If the tenant has multiple employers, you may demand a W-2 statement from each employer. The figures can help you determine if the individual meets your requirements if they intend to keep the job(s).
Pension Distribution Statement
If a prospective tenant receives income in the form of a pension, they can submit a pension distribution statement. Individuals who receive a $10 or more distribution from their retirement plan should receive a copy of Form 1099-R. They can offer you this document to prove their yearly pension distribution.
Income Verification for Potential Renters Without a Conventional Salary
A 9 to 5 job offers easy ways to prove income. But what document can you demand if the potential renter derives their income from a non-traditional source?
If the renter is a freelancer, you can ask to see invoice pages or online wage statements. Most online-based companies pay via PayPal and other payment gateways, which can offer some form of account statement. Freelancers are required to complete IRS Form 1099 for each gig that pays them at least $600. Have the freelancer submit all their IRS 1099 forms to gauge their capability to secure a reliable form of income.
A bank statement is your best bet when dealing with commission-based employees (think retail employees and sales representatives) and self-employed individuals. Bank statements are issued monthly and disclose all the transactions in a particular bank account, including deposits, withdrawals, and fees.
Cash employees, including childcare workers, artists, yoga instructors, landscaping employees, and waitstaff, may find it challenging to present a paper trail for their income. Landlords and rental property managers will likely have to email or call their employees.
Students always need a cosigner (an individual designated to pay the rent if the tenant fails). In this case, verify the cosigner’s income.
Red Flags to Watch out For
Regardless of the documents a prospective tenant submits to you, you expect to get furnished with their current financial position. As such, do not use old documents as income evidence- always check the dates.
Also, most renters tend to list a friend’s number instead of their boss’. You will therefore want to check the numbers independently online or in other trusted sources. Be wary of anything fishy or looks photoshopped.
Determining if a Renter Meets Income Requirements
Now that a tenant has submitted the required income verification documents, how do you determine their capability to pay rent comfortably and not be classified as rent-burdened? An easy way is to use the rent-to-income ratio. The rule of thumb is that the rent should be at most 30% of the tenant’s income; otherwise, the tenant runs the risk of not paying rent consistently.
Assume a potential tenant’s annual income is $60,000 and your monthly rental rate is $2,000:
Tenant’s monthly income = $60,000/12 = $5,000.
Tenant’s recommended rent = $5,000 x 30/100 = $1,500. The prospective renter can only comfortably afford $1,500 in rent, making your rental rate high for them.
You can also use the rent coverage ratio to determine if an individual has the means to pay rent. You obtain the ratio by dividing total income by total expenses. It is recommended that the ratio be at least 1.3.
Let us stick with the previous example but now include total expenses of $45,000. In this case, the rent coverage ratio becomes:
$60,000/$45,000 = 1.33. The ratio is a bit higher than 1.3, making the rent affordable for the potential tenant.
The Bottom Line
Finding high-quality tenants saves lots of trouble and sets you up for long-term financial security. It is therefore highly recommended to include income verification in your tenant screening process. The above are some of the documents you can rely on.
If you struggle to manage the day to day activities related to your rental property, RTI Properties can help with top-quality rental property management services. We take over all property management duties, freeing up time, energy, and peace of mind you need to focus on other important matters of your life without a hassle. Call us today at 310-532-5994 or drop us a message here for more information about our property management services.